RadioShack and a Look Back

Recently, an acquaintance of mine asked my opinion of Radio Shack (RSH) and what I thought of it as a potential investment opportunity for him. After the usual caveats as to “opinions,” I mentioned that I had written an article about the company approximately a year ago. I decided to look at the article and told my friend that I would get back to him.

The article was entitled, “RadioShack: Value or Value Trap?” and what immediately struck me upon reading it was that I had asked the question in the title, but was rather vague in my answer. What was clear was that I wasn’t enthralled with the company. Having read some additional material, I decided to take a second look to see if my opinion, vague as it was, had altered over the last year. After all, I had just come across an article stating that the cable personality we all know as Jim Cramer had visited a RadioShack and had a bad experience with their service, and therefore concluded that the stock would go nowhere. So, I wondered aloud, I must have been correct…. right? (Not really.) If I concluded that a stock was going nowhere because of poor customer service, I can give you a quick list of hundreds of companies that are on their way to nowhere and save you a lot of time and effort in your research.

When I originally wrote the article, I noted that four of the guru investors were currently holding the stock in their portfolio. This included:

Since that time, Greenblatt and Hussman are the only two of the original four that are still holding the stock, and in fact, have added to their position. John Keeley has since joined in and purchased the stock.

It was agreed by virtually all investors at that time, that the electronics industry was hurting and the near-term future was uncertain at best for this industry. Yet as indicated below, Conn’s reversed the path that Radio Shack was on and has become the biggest success story of the lot, Walmart (NYSE:WMT) and Target (NYSE:TGT) began to exert their influence as low-priced leaders and have found their way back to growing their business, Best Buy (NYSE:BBY) (well we all know they are struggling with their business model and are beginning to close some stores) and Amazon (NASDAQ:AMZN) has surprisingly stood still. The RadioShack and Target agreement, which places Radio Shack within the Target stores at their electronic kiosks, has apparently done nothing to help the stock.

At the time of the original article, it was shown how RadioShack’s free cash flow was in a steady decline and that income, profit margins, EBITDA or earnings had flat-lined, indicating no growth at all. So, has anything changed?

While analysts are notoriously incorrect, it is still interesting to see what the expectations of Wall Street are for a particular stock. S&P is expecting that the earnings will drop an additional 28% from the already dismal performance of 2011 and an increase of revenue of approximately 2-3%. Adding that the selling of Verizon products may help, it will be a short-term boost at the very best.

In James Montier’s book, “Value Investing: Tools and Techniques for Intelligent Investing,” he discusses Bruce Greenwald and Judd Kahn’s book where they discuss a three stage process of analyzing competitive advantages. Directly, from the book:

(1) Identify the competitive landscape in which the firm operates. Which markets is it really in? Who are the competitors in each one?

(2) Test for the existence of competitive advantages in each market. Do incumbent firms maintain stable market shares? Are they exceptionally profitable over a substantial period?

(3) Identify the likely nature of any competitive advantage that may exist. Do the incumbents have proprietary technologies or captive customers? Are there economies of scale or regulatory hurdles from which they benefit?

It only takes a moment to realize that some of these competitive advantages such as economies of scale, exceptional profits, captive customers, etc., can be assigned to RadioShack’s competitors, but clearly does not apply to them. They clearly have no moat and are a speck in a sea of large competitors.

A recent report indicates that Radio Shack has struck an agreement with Berjaya Retail, a private company, which will introduce RadioShack into Southeast Asia countries, eventually about 30 countries, by opening an estimated 1000 or more stores. Berjaya Retail mostly operates 7-11’s and Singer stores. I have difficulty seeing how this agreement will pull RadioShack out of the doldrums and make it a major world competitor. Not with the likes of Amazon, Walmart and Target.

But what can we say that has improved or that looks good for the value investor that is looking for a good buy?

Some of the metrics look absolutely tempting.

On the down side, 10-year EBITDA growth is -0.9%, 10-year free cash flow growth is -14.5%, inventory continues to grow in each of the last four years and account receivables are growing faster in proportion to revenues.

I have offered several articles that have favorable ratings based upon Benjamin Graham’s defensive strategy. RadioShack is no different. It rates high with this strategy and fails only on long-term earnings growth. So there you have it: some good, some bad. I’ll go back to my original question and ask, "Is it a great value or a value trap?" It’s about as cheap as it’s going to get. I hope I hear from some that read this article and explain their reasons for their answer to the question.

Ultimately, each investor must make a decision that satisfies his thought process. I will conclude with more finality than my original article by concluding that I see no long-term successful future for RadioShack and end by stating that I believe this stock to be a value trap.

About the author:

David Chulak

David Chulak is a private investor that uses a value approach to investing in the styles of Graham & Dodd and Warren Buffet. Looks for that margin of safety in an effort to preserve capital and attempts to guard against short term market fluctuations by having clear rules laid down in advance for selling an equity. Likes to visit the company's where his investments are in order to understand the business better.

Comments

Good article and great question. RSH is certainly not for the faint of heart. RSH has no competitive advantage and is facing secular decline in profit margins and earnings. Their business model may be obsolete and investors are voting with their feer. The company management is clearly very shareholder friendly (perhaps too much so). Also growth pessimism is built into the price. There does not seem to be any imminent risk of bankruptcy as balance sheet is in good shape.

There are couple of big questions,

1) Can they manage decline? i.e., cut expenses in line with earnings decline.

2) Is RSH a takeover target or a private equity play? If so what is the take out price?

You articulated what I did not and that was "The company management is clearly very sharefholder friendly (perhaps too much so)".

You are correct....I think they are almost shareholder friendly to the point of self destruction. Perhaps overstated. It's an interesting stock. They have managed to improve book value slighly from the prior year and have an incredible P/B ratio of 0.8. It will be interesting to watch their progress....or the lack thereof.

Management will have to make some drastic changes if they want to set "The Shack" up for a long term growth trend. Otherwise the stock will keep going 'peak-to-peak'; $67-$35-$15-$6-etc. David mentioned the Company has opened up mobile outlets in Target branches to lackluster results. I did not even know Radio Shack provided mobile services (the branch near my neighbourhood in East Vancouver closed quite a few years ago and I don't see any around in my travels...).

I was particularly amused by Management's decision to execute a new way forward by trademarking and pushing the new moniker "The Shack". Then I read in Part 1 of the 2010 10-K the following statement: "We believe the RadioShack name and marks are well recognized by consumers, and that the name and marks are associated with high-quality products and services. We also believe the loss of the RadioShack name and RadioShack marks would materially adversely affect our business." LOL

Although it is interesting to armchair analyze this company, the fact remains that a hated and unloved stock is the best time to purchase shares thereof. If the stock drops below $5, I think we can safely assume there will be some astute buyers snapping up cheap 8% dividend yield shares. Not to assume anything here, but the fact is there have been some great profit opportunities on this stock: June '06 - June '07 and March '09 - April '10.

p.s. thanks David for doing a writeup on a stock that is in a formidable downtrend - your conclusion notwithstanding. I get tired of guys coming on here and hawking stocks that are trading at all-time-highs.

The big problem for Radio shack and even Best Buy is that they are competing with more competitors in the narrower market (smartphone retail market). Without changing this fact, they have a long long way to go.

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